Pension funds must consider other investments

Clive Mphambela

PENSION funds should consider alternative investment strategies in order to boost sustainable returns, diversify risks and deepen Zimbabwe’s financial markets, Ecobank Asset Management CEO Yona Banda said.

Presenting a key paper on Alternative Investment Strategies for Pension Funds at the recent annual Zimbabwe Association of Pension Funds congress held in Victoria Falls, Banda said traditional investment strategies had shortcomings in that they were now leaving Zimbabwean pension funds with portfolios concentrated largely in listed equities and money market investments, with very little diversification.

Banda was highlighting what he saw as the problems of the traditional approach to investment, which leaned mainly on the attitude of managing assets to maximise returns, whilst taking risks as given.

“This approach has led to the heavy reliance on equities, property and bonds for most pension funds in Zimbabwe. However, with the bond market in Zimbabwe having virtually disappeared since dollarisation, this has left pension funds invested in traditional assets, mainly in equities and money market deposits with banks,” Banda said. He added that using the modern alternative approach entailed managing returns and managing risk, while ensuring better portfolio performance.

Banda pointed out that equities carried two kinds of risk; firstly the volatility associated with share prices, which introduced what he termed “an equity risk premium”, and the risk of not keeping up with pension liabilities as interest rates, inflation and mortality changed.

“The unrewarded risks cause damage to portfolio returns if they are not controlled,” Banda said.

He told delegates that traditional bonds were also risky despite the lower “risk’ measured by volatility of interest rate returns. The perceived lower risk came at the expense of a big reduction in upside potential.

Banda argued that bond investments still contained a huge element of “unrewarded” risks such as salary inflation, credit risk, longevity of pensioners and were therefore not a perfect match for pension liabilities.

According to Banda, alternative investments sometimes offered a better risk/return profile than traditional bonds or equities.

Firstly, they offered low correlation with traditional assets, so returns and prices would not follow the pattern of the traditional assets. This low correlation among alternatives could be used to manage risks and returns on a sustainable basis.

Banda pushed for an alternative asset allocation approach which encompassed putting return-seeking assets that aim to generate high returns such as private equity, property, infrastructure and commodities in an asset portfolio. These would have to ideally balance off with derivative instruments if they were available.

“The key attractiveness of such alternative assets is that investors can benefit from market inefficiencies and conditions of market illiquidity,” he said.

A sound portfolio had to also have liability matching or hedging assets to protect the downside such as bonds and other fixed income assets for cashflow. Investors could also make use of derivatives and swaps for closer liability match, he said.

Banda believes private equity investments,that is, investments in the shares of unlisted companies, provided a vast opportunity for pension funds in Zimbabwe.

“Pension funds should also consider investment in infrastructure such as toll roads, toll railway and toll bridges, alongside commercial property and housing,” he said.

Mineral commodities such as gold, copper, platinum and diamonds as well as agro commodities such as maize, wheat and sugar could also provide useful returns.

Banda suggested investors could consider microfinance as an asset class in which they could participate via an appropriate private equity model.

He listed the key drivers of private equity growth in Africa as rapid economic growth and increasing political stability.

Africa also offered huge scope due to limited private equity penetration and lower competition for deals.

Powerful demographic trends and an increasing legacy of good corporate governance and increasing regional co-operation had meant that investors could now access attractive opportunities with limited capital input.

However, the attractiveness was dented by the shortage of experienced fund managers and the absence of robust intermediary network-advisors, bankers, brokers and data providers.

This also meant a limited exit environment due mainly to limited availability of trade buyers and fewer Initial Public Offerings (IPOs).

“The trick with private equity is not in investing-but in divesting” Banda said, adding that the key issues to consider for trustees included taking a long-term perspective on their investments that fitted the objectives of their pension scheme. In choosing the fund manager(s), strong consideration had to be placed in the ability to exit the investment should the need arise,” he said.

Infrastructure investments offer diversification and consistency and reliability of returns over long term investment horizons and also a variety of investment options.

However, some concerns about infrastructure investments were that returns could be relatively low and inflation risk made it difficult to guarantee the sustainability of positive and relatively low-risk returns over long periods of time.

In addition, local regulations could be unpredictable, leading to the risk of regulatory oversight. However, there was stable and growing demand for essential services, and the highly regulated and the long-term nature of contracts protected cashflows.

Risks existed in relation to the financing costs, building costs and eventual usage of infrastructure projects.

Banda believed Zimbabwe’s pension funds also needed to develop a securitisation market but required to group together assets that gave a market with sizeable volumes.

“We also need standardised assets, and appropriate legal and regulatory framework supported by active government participation,” he said. Securitisation could only complement existing investment options.

Banda also called for the creation of a Corporate Bond Market which was now critical given the absence of the government bond market.

There were key environmental factors and regulations that were hampering the development of alternative investment markets.

“The high fees charged by experts in the field are a deterrent. The complex nature of some alternative investments also mean that due diligence can be expensive and time consuming,” he said.

On the other hand,trustees and investors were also nervous about the unfamiliar, and the lack of in-depth understanding needed to be addressed.

For alternative investments to appeal in the Zimbabwean context, there was need for trustee education. Asset managers and financial advisors needed to offer advice in a language trustees could understand.

The focus had to be on risk reduction and return enhancement with respect to each scheme’s liability profile.

 

 

 

Top